Financial Reporting Council to investigate ethics at audit firms

Ethical standards at British audit firms are under investigation after the
Financial Reporting Council (FRC) said it had found evidence that the
breaches it uncovered at KPMG last month maybe more widespread.

In May, the FRC announced a double investigation into KPMG and whether it had breached the professions Ethical StandardsPhoto: Paul Grover

Britain’s reporting watchdog said it is “undertaking a review of recent director appointments across an extensive sample of the FTSE350” amid concern that standards of independence between auditors and companies are not being properly upheld.

In May, theFRC announced a double investigation into KPMGand whether it had breached the professions Ethical Standards. One part of the probe was based on the appointment of Mel Egglenton as chairman of Pendragon, one of the Big Four company’s clients. Mr Egglenton was appointed only nine months after he stepped down as a partner of KPMG and less than six months after completing consultancy work for the firm. Another part was whether KPMG had committed an ethical breach “in relation to the non-timely disposal of a shareholding in a client entity”.

In its annual report on audit standards published today, the FRC said it was seeking to “identify any further instances where there may have been a breach of the Ethical Standards.”

The FRC demanded an overall improvement in ethical standards saying it had found various breaches including effort to cross-sell non-audit services to audit clients, a failure to get proper clearance for contingent fee arrangements, and “instances where shareholdings in audited entities were not disposed of on a timely basis.” The report added that too many auditors were issuing standardised reports: “We continue to see firms adopting a “boilerplate” approach to their independence reporting.”

The FRC has also criticised audit firms for lapse standards in their work on London-listed companies whose activities are almost entirely overseas. The report found: “We identified a number of instances in respect of the audit of “letterbox companies” where reliance was placed primarily on sign-offs from component auditors, with the group or company auditor insufficiently involved in the control, supervision and review of the audit work.” Paul George, Director of Conduct at the FRC, said that UK auditors needed to “take more responsibility” even if the preparatory work is done by other firms overseas.

On financial services audits, the FRC called for “further improvements”, particularly with regards to testing the way loan losses are calculated. “Firms should strengthen their testing, particularly in respect of loan loss provisioning and general IT controls,” the report found.

Overall the FRC said that there had been an improvement in the standard of audits across the FTSE350 with 59pc of those inspected being categorised as good or acceptable compared to 46pc last year. However 15pc of audits were assessed as requiring “significant improvement” compared to just 10pc of the sample tested last year.